More attacks likely against tax breaks for U.S. munis

SAN ANTONIO, Texas Oct 14 Legislative strikes
against the tax exemption associated with U.S. municipal bonds
are not likely to end soon, but will probably come in a variety
of forms, according to analysts and lawyers.

"Let me assure you that, very unfortunately, reports of the
demise of the 28 percent cap are greatly exaggerated," said
Victoria Rostow, director of governmental affairs for the
National Association of Bond Lawyers at an association meeting
on Thursday.

In the American Jobs Act proposed last month, President
Barack Obama suggested capping the size of the tax breaks that
high-earners can take for the interest payments they receive
from the municipal bonds they buy.

Tax exemption is a key selling point for the debt that
states, local governments and authorities sell, allowing them
to pay lower interest rates.

Rostow, though, said that the defeat of Obama's plan in the
Senate did not end the possibility of a cap, because Congress
may take up parts of the plan in separate bills.

A bicameral, bipartisan committee created to cut the
deficit could also suggest bringing in revenues through
limiting the exemptions, she said. The so-called
"SuperCommittee" has until Nov. 24 to make suggestions.

For Antonio Martini, an attorney at Edwards Angell Palmer
& Dodge LLP in Boston, the tax exemption is in a "policy-making
crucible," where different bills and proposals arose in the
last year to change, limit or eliminate it.

"There's a broad spectrum," he said.

Alongside Obama's cap, an independent deficit reduction
commission, known as Simpson-Bowles for its leaders, recently
suggested wiping out the exemption entirely.

Senator Ron Wyden has introduced a bill to replace some
infrastructure bonds with bonds that give credits against their
tax charges instead of paying interest.

The popularity of last year's taxable Build America Bonds
have "framed some of the discussions going on now about
possible changes," said Scott Lillienthal, an attorney from
Hogan Lovells US LLP in Washington at the conference.

The bonds pay issuers a rebate equal to 35 percent of
interest, a subsidy so steep they caught on like wildfire. The
federal government considered the bonds more "efficient" than
tax-exempt debt, where issuers benefit from the subsidy
indirectly and the investor base is narrow.

The federal government will likely rescind the tax
exemption "step by step by step," said Charles Almond, an
attorney at Vinson & Elkins LLP in Houston.

It will likely begin limiting the exclusion on private
activity bonds sold for projects that fall outside the purview
of typical public works or for those sold in conjunction with
non-profits known 501c3s for their part of the tax code.
Ultimately, he said the federal government could simply leave
the tax exemption for debt related only to essential
governmental functions.

"The threat is very real," said George Friedlander, Citi's
senior muni bond strategist, agreeing that the federal
government may simply chip away at the exemption, so that "we
end up with half the existing market."

Friedlander, who suggested giving issuers the option of
selling BAB-like debt at a lower subsidy rate or tax-exempt
bonds, said that the threat to the exemption would persist.

"Once something is proposed it never dies. It will be
brought up again and again and again."